Effect of Accounting Flexibility on Earnings Management through Stock Repurchases

Randall Zhaohui Xu, Yi Yang

Abstract

Prior research (Taylor & Xu, 2012) finds that firms that attempt to increase EPS to meet analyst forecasts throughstock repurchases give up the opportunity to time their buybacks to benefit from temporary undervaluation oftheir stock as is the case for firms that repurchase stock for other purposes. The current study explores a possibleexplanation for the costly behavior by investigating whether firms with constraints in their ability to inflateaccruals are more likely to use stock repurchases as a means to manage earnings. The research question is testedusing a logit regression model with quarterly data from 1992 to 2009, controlling for various previouslydocumented factors that affect stock repurchases and/or earnings management. The empirical test results areconsistent with the hypothesis that firms with lower accounting flexibility are more likely to manage earningsthrough stock repurchases. The study contributes to the earnings management literature by documenting thesubstitution effect of alternative means of earnings management.

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